Investor Briefing: Q1 2020

We are living through a historic episode in world history. COVID-19, more commonly known as the coronavirus, has presented a serious threat to the health and well-being of our global community. To date, the outbreak has infected over 1.5 million people and claimed the lives of over 91,000 people across 209 countries globally. The numbers continue to climb, and many of us now know someone who has been infected.
 
Containment efforts across the US, such as the closure of non-essential businesses and shelter-at-home, are our best way to slow the contagion. However, these efforts are adversely affecting the economy. Many businesses have been closed for over two weeks. The federal government has suggested that these measures should remain in place until the end of April and possibly longer. That is effectively 10% of the revenue days for the year. Consequently, many companies have had to furlough and lay off staff. Jobless claims have surged over the past two weeks and economists are expecting unemployment to rise sharply in coming weeks.

Economic Impact of COVID-19

The stock market would suggest that the US is in a recession. Technically, a recession is comprised of at least two consecutive quarters of declining GDP. Wall Street firms have already begun reducing GDP forecasts and earnings estimates for the year. According to CNBC, economists expect Q1 GDP to decrease 5%, followed by a 27% drop in Q2 before recovering in Q3. Meanwhile, consensus earnings estimates for the S&P 500 have been cut to -5% for 2020 and are likely to be reduced further. Recall that at the beginning of the year, consensus estimates were +9%. Goldman Sachs estimates a larger decline of 33%. That may seem steep, but if businesses lose 10% of their revenue days, earnings for the S&P could be down much more than 5% for the year. Whether earnings are down 5% or 33% (likely somewhere in between), it is clear that earnings are languishing and will be down sharply for the year.
 
We believe that the near-term outlook remains uncertain. The question that the investment community is grappling with is how much of the negative news is already discounted. Some bearish investors believe that the market is experiencing a bear market rally that will fade and retest the lows of March 23. We do not know how long or how deep the recession will be. However, we are optimistic that the outbreak will pass as it appears that this virus, like other coronaviruses, has a seasonal component.

Q1 2020 Performance

Over the medium- to long-term, we remain confident that equities will appreciate. The key is to invest in quality companies that have durable business models and strong balance sheets. This is the approach we have been taking in our JSO equity model. The portfolio has been recalibrated to reduce risk and position our clients to participate when the stock market does recover.
 
The year started out strongly for the equity market following a robust fourth quarter performance in 2019. The S&P 500 rallied to a new high of 3,386 on Feb. 19. Since then, the market corrected and entered into a bear market, ending the quarter down -20% at March 31. The JSO Equity Portfolio also fell but to a lesser extent, declining 14.5%.
 
Our equity portfolio’s outperformance can be attributed to two key factors: fund selection and risk management. One of our key funds, Akre Focus Fund, has proven resilient during the correction. The fund manages about half of our total equity holdings and declined just 11.2% during the first quarter. We also reduced our equity exposure by 20% in October 2019. That decision helped us generate over 3 percentage points of alpha (i.e. outsized return relative to the market).

Near-Term Strategy

Data from the past week suggests that infection rates are slowing. While this news is encouraging, we feel it is premature to conclude that the worst is behind us. There is too much uncertainty around how deep or long the economic impacts of this outbreak and nationwide shutdown will last. Our baseline view is that the market will discount the negative effect of the outbreak over the next 3-6 months, assuming that infection figures will peak in May or June.
 
We are vigilantly following the market and looking for attractive opportunities to reinvest our cash position. We recently put 5% of our cash portion, generated by our recent exit from Yacktman and SouthernSun, into an S&P 500 index fund. Our plan is to continue adding broad equity exposure over the near-term. As economic conditions stabilize, we intend to reallocate from the index fund into more concentrated equity funds and work towards being fully invested at our clients’ original equity/fixed allocations.

Long-term Strategy

We believe that investing in stocks remains one of the most attractive vehicles for long-term capital appreciation. In uncertain times such as these, it is important to remain grounded and sober. We rely on our portfolio managers to select the durable companies to invest in, while we apply a risk management overlay to adjust our equity exposure. Understanding where market valuations are has helped us reduce risk going into this bear market. We will rely on the same investment framework to scale back into the market.   
 
While all of our lives have been upended by the COVID-19 pandemic, we continue to believe that this is episodic and not structural. This season will pass, and many of us will emerge from it even stronger. At JSO Partners, our aim is to position your portfolio to endure this volatile financial market and capitalize on the opportunities presented.

If you would like to learn more about the JSO Equity Model, please do not hesitate to contact us.

Contact Us
(215) 283-3131
team@jsopartners.com